MONEY

Barter

In Politics Book 1:9 (c.350 B.C.) the Greek philosopher Aristotle contemplated on the nature of
money. He considered that every object has two uses, the first being the original purpose for
which the object was designed, and the second possibility is to conceive of the object as an item
to sell or barter.

With barter, an individual possessing any surplus of value, such as a measure of grain or a
quantity of livestock could directly exchange that for something perceived to have similar or
greater value or utility, such as a clay pot or a tool. The capacity to carry out barter transactions
is limited in that it depends on a “coincidence of wants”.

Money
Money is any object or record that is generally accepted as payment for goods and services and
repayment of debts in given socio-economic context or country.

Functions of Money

The basic function of money is to facilitate exchange transaction of goods and services.
However, in the performance of such function, money has been observed to discharge the
following incidental functions: as a medium of exchange; as a measure or standard of value;
as a store of value and; as a standard of deferred payment.

As a medium of exchange

If the troublesome problem of the “double coincidence of demand” is to be avoided, it is

necessary that some readily available thing must be available as a medium of exchange that will
bring about a smooth and effective transfer of goods from one hand to another. Thus, the need
for something that will serve as an intermediary in the process of exchange.

A measure of standard of value

The importance of money as a common denominator of value is that it establishes a common

denominator or yardstick by which units of goods or services may be measured in terms of their
exchange value. The existence of standard of value facilitates comparison of relative values
among all things.

A store of value

The use of money as medium of exchange for present and future transactions will give rise to its
use as a store of value. Knowing that it represents general command over a variety of goods,
people may decide to hold money, that is, save and thereby store “value” thus enabling them to
obtain the goods they may want and need any time in the future.

As a standard of deferred payment

Money serves as a standard of deferred payments in all debts, which are contracts expressed in
terms of money. All debts which specify the repayment of a definite sum in the future are using
money as a standard of deferred payment.

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Money as a Conveyance

A far as the national economy is concerned, money is merely a conveyance where the flow of
production is facilitated and enlarged through specialization and division of labor.

Kinds of Money
Commodity money is money that would have value even if it were not being used as money
(this is usually referred to as having intrinsic value). Many people cite gold as an example of
commodity money, since they assert that gold has intrinsic value aside from its monetary
properties.

Commodity-backed money is a slight variation on commodity money. While commodity

money uses the commodity itself as currency directly, commodity-backed money is money that
can be exchanged on demand for a specific commodity.

The gold standard is a good example of the use of commodity-backed money- under the gold
standard, people were not literally carrying around gold as cash and trading gold directly for
goods and services, but the system worked such that currency holders could trade in their
currency for a specified amount of gold.

Fiat money is money that has no intrinsic value but that has value as money because a
government decreed that it has value for that purpose. While somewhat unintuitive, a monetary
system using fiat money is certainly feasible and is, in fact, used by most countries today.

Fiat money is possible because the three functions of money- a medium of exchange, a unit of
account, an a store of value- are fulfilled as long as all people in a society acknowledge that the
fiat money is a valid form of currency.

Legal Tender

In whatever form or kind in which money may circulate, one common characteristic is that they
possess the stamp of legal tender, which may be described as “any kind of money which,
according to law, must be accepted when offered in payment of any obligation expressed in
terms of the country’s monetary unit”.

In the Philippines, coins shall be legal tender in amounts not exceeding P50.00 for
denominations from P0.10 to P1.00, and in amounts not exceeding P20.00 for denominations of
P0.05 or less.

Money Creation
In economics, money creation is the process by which the money supply of a country or a
monetary region (such as the Eurozone) is increased. A central bank may introduce new money
into the economy (termed 'expansionary monetary policy') by purchasing financial assets or
lending money to financial institutions. Commercial bank lending also creates money under the
form of demand deposits). When banks had sizable reserve requirements (freezing an important
percentage of their deposits in mandatory reserves at the central bank) it was said that the process
multiplied this base money through fractional reserve banking.

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Money Creation by the Central Bank

Monetary policy regulates a country's money supply, the amount of broad currency in
circulation. Almost all modern nations have special institutions (such as the United
States Federal Reserve System, the European Central Bank (ECB), and the People's Bank of
China) for conducting monetary policy, often acting independently of the executive. In general,
these institutions are called central banks and often have other responsibilities such as
supervising the smooth operation of the financial system.

Quantitative Easing

Quantitative easing involves the creation of a significant amount of new base money by a central
bank by the buying of assets that it usually does not buy. Usually, a central bank will conduct
open market operations by buying short-term government bonds or foreign currency. However,
during a financial crisis, the central bank may buy other types of financial assets as well.

The central bank may buy long-term government bonds, company bonds, asset backed securities,
stocks, or even extend commercial loans. The intent is to stimulate the economy by increasing
liquidity and promoting bank lending, even when interest rates cannot be pushed any lower.

Physical Currency

In modern economies, relatively little of the supply of broad money is in physical currency. The
manufacturing of new physical money is usually the responsibility of the central bank, or
sometimes, the government's treasury.

Contrary to popular belief, money creation in a modern economy does not directly involve the
manufacturing of new physical money, such as paper currency or metal coins. Instead, when the
central bank expands the money supply through open market operations (e.g. by purchasing
government bonds), it credits the accounts that commercial banks hold at the central bank
(termed high powered money). Commercial banks may draw on these accounts to withdraw
physical money from the central bank. Commercial banks may also return soiled or spoiled
currency to the central bank in exchange for new currency.

Money Creation through fractional reserve banking

Fractional-reserve banking is the practice whereby a bank holds reserves in an amount equal to
only a portion of the amount of its customers' deposits to satisfy potential demands for
withdrawals. Reserves are held at the bank as currency, or as deposits reflected in the bank's
accounts at the central bank. Because bank deposits are usually considered money in their own
right, fractional-reserve banking permits the money supply to grow to a multiple (called
the money multiplier) of the underlying reserves of base money originally created by the central
bank.

To mitigate the risks of bank runs (when a large proportion of depositors seek withdrawal of
their demand deposits at the same time) or, when problems are extreme and
widespread, systemic crises, the governments of most countries regulate and oversee commercial
banks, provide deposit insurance and act as lender of last resort to commercial banks. In most
countries, the central bank (or other monetary authority) regulates bank credit creation,
imposing reserve requirements and capital adequacy ratios. This can limit the amount of money
creation that occurs in the commercial banking system, and helps to ensure that banks are solvent
and have enough funds to meet demand for withdrawals. However, rather than directly limiting
the money supply, central banks typically pursue an interest rate target to control bank issuance
of credit.

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